Lean Accounting & Standard Costing: An Introduction

If you are in the accounting department in a lean manufacturing company, and your company uses a standard costing system, it is inevitable that the accounting department will be faced with confronting how its standard costing system is being used.

I stress the term inevitable, because based on my own experience both as a CFO and a consultant, I have seen it happen consistently. Sometimes the confrontation will occur early in the lean journey, sometimes later, but it is going to happen.

My advice to the accounting people in accounting departments of lean manufacturing companies is to lead rather than react. Be the leaders of proactively evaluating how the standard costing system is being used as your lean journey begins and come up with a plan.

Coming up with a plan is not difficult, as long as you understand the issues. Fortunately these issues happen to be very common across lean manufacturing companies that use standard costing systems. For the next few blogs, I am going to write in detail about the issues, look into exactly why these issues occur and lay out solutions.

I see 6 issues that accounting will have to deal with in a lean manufacturing company:
1. The financial & operational impact of variances and overhead absorption
2. The financial impact of inventory reduction
3. Internal financial analysis & business decision making
4. Inventory valuation
5. Maintaining GAAP/IFRS compliance
6. Other – such as transfer pricing or maintaining local regulatory compliance

Before we get into the issues, I think it’s important to get some background on why standard costing even becomes an issue in lean manufacturing companies.

The Root Cause
The primary root cause of why accounting will have to deal with standard costing is twofold. Accounting needs standard costing to value inventory but lean operations does not need, nor have any use for, the performance measurement & financial analysis aspects of a standard costing system.

Conflict between accounting and lean operations occurs when each side doesn’t understand each other’s reasoning.

Lean operations people don’t like the performance measurement & financial aspects of a standard costing system because standard costing systems are based on mass-production manufacturing practices and lean operational practices are 100% opposite of mass-production practices.

It’s important for accounting to recognize this and not try to force lean operations to use standard costing information to measure or manage lean operations.

Accounting needs standard costing to value inventory for GAAP/IFRS compliance. In most manufacturing companies with high inventory and many SKU’s, this is the simplest and easiest way to value inventory. And ERP systems are set up to do this, which automates the process. Accounting has another obligation, which is being able to explain the financial impact of the financial information a standard costing system produces, such as variances, absorption and margin.

It’s important for lean operations to understand accounting responsibility for maintaining GAAP/IFRS compliance and “stop using standard costing” is not a simple to do.

First Steps in Leadership
I mentioned earlier that accounting should lead the discussion on using a standard costing system in a lean manufacturing company. Here are 4 initial leadership steps accounting can take.
• It’s a company problem not an accounting problem. Accept that your lean manufacturing company will have to deal with standard costing. Information from standard costing systems are used in all parts of a manufacturing business, and for many different reasons. The entire company will have to be part of the solution.
• It’s a long journey not a short destination. It’s going to take time to adapt, improvise & overcome a standard costing system. Just like a Lean journey, there will be successes, and adjustments along the way. The larger to company, the longer it will take.
• Begin communication of the issues. The CFO needs to begin talking to senior management. The controller needs to engage lean operations management. The entire accounting function needs a continuing dialogue on this topic. Begin laying out the specific issues your company is going to face over the long run.
• Lean accounting practices & methods do provide a path & solution to resolving these issues in your lean manufacturing company. Learn about Lean Accounting.

Nick’s Lean Accounting Journey

Nick has leveraged this experience along with his strong accounting background to assist companies resolve the real-world issues they face when implementing lean accounting. He facilitated Lean Accounting implementations with a wide range of companies, from multi-national companies such as Boeing, Parker-Hannifin, Novartis and Nestle to privately held family businesses. Nick’s industry experience includes applying lean accounting in manufacturing, engineering, food processing, process manufacturing, publishing, education and health care.

Nick is co-author of The Lean Business Management System; Lean Accounting Principles & Practices Toolkit (2007). Nick’s latest book, The Lean CFO: Architect of the Lean Management System was published in September 2013.

Nick is a Certified Public Accountant and a member American Institute of Certified Public Accountants and holds a BS in Accounting and an MBA in Finance, both from the University of Kentucky.